Chinese Pulling Back on Treasury Buying -- Implications for Markets and Fed

The latest significant market development is apparently the Bloomberg report that China is considering pulling back from buying Treasuries.   But, even if, as is likely, today's market reactions reflect exaggerated fears of what the Chinese may do,  there are reasons to think that the markets' reactions should not be extrapolated
 
Initially, a Chinese pullback in Treasury buying -- or talk of one -- clearly boosts longer-term yields, as attested by this morning's jump, and should be a negative for the dollar and likely stocks.   The dollar is hurt by the possibility that Chinese will buy less of the currency.   The impact on stocks is mixed.  They will be hurt by higher yields -- pulling down discounted profits, but helped by a weaker dollar -- boosting the value of overseas profits.  

But, the implications for Treasury yields and stocks would become less negative if the downshift in Chinese buying of Treasuries results in less aggressive Fed tightening -- even if in the short term implications for Fed policy are more market talk than reality.

Talk of a less aggressive Fed would stem from the idea that a pullback in Chinese buying of Treasuries will hurt the US economy.  From this perspective, the market moves are mixed.  Higher yields will restrain interest-sensitive sectors, like housing.   And, softer stocks will weigh on consumer spending.  But, the weaker dollar would help net exports. 

If economic growth looks to be hurt, the markets should adjust to being net pro-growth if the Fed signals that it still wants economic growth to be at a good pace.   Using an "optimal-control" approach to understanding markets, yields will fall back somewhat and stocks would resume climbing if the weaker dollar is viewed as insufficient to achieve the desired economic growth rate.